Rationale and Impact of the Salomon Principle

I. Introduction

As a landmark case in UK company law, the judgments to the Salomon case1 gives effects on upholding the principle of corporate personality. As a result, company’s shareholders would not be liable for the debts of an insolvent company. Seeing the decision in Salomon v Salomon Ltd, a company is formed if it has separated legal personality and limited liability. Furthermore, shareholders, directors are divorced with the company itself. They are independent entity under the law.

II. The ‘Salomon’ principle

In this case, Mr Aron Salomon was a merchant manufacturing leather boots and shoes. He ran his own business as a sole trader. By the year his sons preferred to be his partners, Salomon decided to incorporate his business as a Limited company, Salomon & Co Ltd. Complied with the Companies Act 1862 (whose descendant is the Companies Act 2006) s62 which provided that seven or more persons together could incorporate a business, Mrs Salomon and their five children became subscribers. Mr Salomon himself was managing director. The business was valued £39,000 when purchased by the company. Mr Salomon owned 20,001 of the company’s 20,007 shares. Each of his family members allotted 1 share in the company. Salomon received the value of £10,000 in the form of secured debentures. These debentures were secured by means of a floating charge over the assets of a company. The remainder £9,000 was paid by cash. In this way he became both the company’s principal shareholder and its principle creditor at the same time. Coping with stress of fund shortage, Salomon transferred half of the debentures to Broderip for £5,000 and entered his name.

The company met faults finally because of the strikes, failing to meet the interest payments on debentures. The debentures held by Broderip could not be paid off at that time. As the requirement of unpaid trade creditors, the company went into liquidation. The assets were sold off so that sufficient funds could be used to pay the debt. However, the secured debentures ranked in priority to the trade creditors. As a result, £5,000 was repaid to Broderip. There was still a remaining asset of £1,055 available. Mr Salomon then claimed the funds to cover his retained debentures and thus other unsecured creditors got nothing paid. The liquidator argued Salomon was liable for the company’s debt. He believed the company was an agent of Salomon in this way.

In the first instance court, the case Broderip v Salomon [1985] 2 Ch 323 was judged that Mr Broderip’s claim to be paid off by the company was valid, for the loan was secured and in priority to unsecured trade creditors. Nevertheless, the liquidator counter-claimed Salomon was responsible for the unsecured debentures personally. The judge, Vaughan Williams J accepted this argument. He held that since the company was transferred solely with spurious reasons. He said that the company was just a nominee, an agent of Mr Salomon in reality. Therefore, Salomon should pay the unsecured debentures personally.

The court of Appeal upheld the decision of Vaughan Williams J against Salomon. However, the reasons were not the same with High Court completely. The judge recognized that the business formed to a legal entity validly in complying with the 1862 Act s6 s83, but the court would not agree that the debts should be separated with its founders, Salomon. The court believed that Salomon incorporated the company with a hidden purpose. This was a ruse of running the business as before with a limited liability. Lindley LJ held that there was a trust relationship between the company and Salomon, and thus Salomon was bound to cover the debts.

The House of Lords denied the judgment in reserving the decision of the Court of Appeal. They rejected the arguments from agency and fraud. The House held that the incorporation followed the Companies Acts 1986 and there was a fact that once the business was